Goodbye to rate cuts in a great little economy

This could be the week Australians finally decide the economy is not doing all that badly.

Perhaps many will not want to believe Treasurer Wayne Swan when he said Australians should have a “spring in their step".

But they might want to believe Reserve Bank of Australia governor
Glenn Stevens
who said on Friday: “An objective observer coming from outside would, I think it must be said, feel that Australia’s glass is at least half full."

The key piece of economic data from the past week was that gross domestic product grew 1.3 per cent in the March quarter and 4.3 per cent for the year, the fastest since the height of the boom during the Howard years in 2007 and better than other advanced economies.

The growth figure is artificially high because the starting base was the period of the Queensland floods last year. But even if you look at just the past six months, growth has been close to 4 per cent on an annualised basis. The government’s budget forecast of 3.25 per cent growth is looking quite plausible.

The sceptics will highlight that Australia is hostage to the mining boom. They warn that the price of commodities is falling and China is slowing fast. But Stevens said Australians are showing a degree of irrational unexuberance equal to the irrational exuberance they showed five years ago. “Even before the recent turn of events in Europe and their effects on global markets, we were grimly determined to see our glass as half empty."

His optimism is based on the belief that for the next year or two, the mining boom is locked in. According to the national accounts, spending on non-dwelling construction, almost all in mining, climbed 12.6 per cent in the March quarter, adding 1 per cent to GDP.

This investment is likely to continue at a cracking pace in all but the most catastrophic scenarios emerging from China or Europe.

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There has been some discussion recently about whether
BHP Billiton
might decide not to proceed with new projects such as Olympic Dam in SA because of global uncertainty and high costs. But most of the projects in the $500 billion pipeline of big LNG, iron ore and coal investments that the RBA is counting on to drive growth are so far advanced and long term that they are definitely going ahead, even if China slows. Stevens on Friday predicted that business capital spending would rise by another 2 percentage points of GDP in 2012-2013 to reach a 50-year high.

Pessimists argue the price of our exports is falling, with the terms of trade down 4.1 per cent over the year. But this is still very high by historical standards, about 15 per cent above the peak during Mining Boom Mark I. Commodity prices would have to fall a lot further to make the most advanced projects unviable.

So the main impact of the likely fall in commodity prices will be on a few marginal mining projects, and then on the profits of resource companies. That is tough. But mining companies are currently very profitable and about 80 per cent of their shareholders are offshore anyway. Australians will mostly suffer because taxes from mining will be lower, which will make it harder for governments to balance the books.

Until this week, it was possible to argue that things might be good in the mining sector but not in the rest of the economy. Retailers, the housing industry and anyone in the eastern states have all complained about cautious consumers, high interest rates and global uncertainty.

But the national accounts show consumers are not that cautious. Household consumption spending grew 4.2 per cent in real terms over the year and 1.6 per cent in the March quarter, providing the other main driver of growth. Spending is weak in the shops but it is growing fast on eating out, health and travel.

Moreover, Stevens was at pains to point out that despite the talk of a two-speed economy and the ravages of Dutch disease and a high dollar on the eastern states, it is not just WA and Queensland doing fairly well. The unemployment rate in NSW and Victoria, which are supposed to be in the economic slow lane, is only about 5 per cent and within spitting distance of WA on 3.8 per cent.

“In the face of the understandable concern about job losses in particular regions and industries, the dispersion of unemployment rates by statistical region is no larger today than has usually been the case over the past 20 years," Stevens said.

Some economist have claimed that the low unemployment rates were misleading and, until this week, they preferred to highlight the generally weak growth in the figure for employment, notably full-time employment. Full-time jobs, as measured by the Australian Bureau of Statistics, were flat over most of 2011. This was always a questionable argument since it is much harder to calculate the total jobs created than the unemployment number which is generated from a simply survey.

In any case, the employment data this month showed that more than 46,000 full-time jobs were created in May, the most since November 2010. Trend employment growth is about 1 per cent, which is quite solid and close to growth in the size of the work force, which will slow the rise in unemployment.

So why are Australians so gloomy? Stevens blames it on griping from sectors that did best during the boom years under Howard and are reluctant to adjust to new structural pressures. Home owners and borrowers are disappointed that house prices are static rather than growing at unsustainable bubble rates, bricks and mortar retailers are annoyed by the shift in spending to the internet and to other forms of consumption such as health and education. Banks are seeing less demand for credit.

Stevens says none of this has much to do with the mining boom. The key thing is that the economy is going through technological change and Australians have collectively decided they will not return to the debt-fuelled consumption binge of the noughties. Stevens will not do anything to encourage them. “It is not our intention either to engineer a return to a housing price boom, or to overturn the current prudent habits of households," Stevens said.

On the other hand, by cutting official interest rates by 1.25 percentage points since November, the RBA has acted to ensure the weakest sectors such as house construction will have time to adjust to the transition.

One mystery is why Stevens chose this moment to engage in what he described as “cheer leading" for the national economy. It comes only a few days after he said economic growth was “modest" in the statement issued after the RBA board meeting this past week. Perhaps he wanted to correct the record.

But his political purpose was clearly to fend off the pressure from lobby groups for more rate cuts to solve the structural problems caused by the shift away from Howard-era spending patterns and the mining boom. CBA chief economist Michael Blythe suggests this was not a speech designed to raise expectations of more rate cuts: “The implication is that we should not expect to see a never-ending series of small interest rate cuts designed to shore up business and consumer confidence."